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HWA CHONG INSTITUTION
C2 Block Test 2 2015
Higher 2
ECONOMICS
9732/01
Paper 1
1 July 2015
2 hour 15 minutes
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HWA CHONG INSTITUTION
[Turn over
2
Answer all questions.
Question 1 The world market for cocoa bean and the chocolate industry
Extract 1: World price of cocoa bean could more than double by 2020 if output lags
World price of cocoa bean could more than double by 2020, rallying to a level last seen 36 years
ago, if production fails to catch up with demand. There has been a shortage of cocoa beans, which
are roasted and ground to make chocolate.
In Ivory Coast, where 70% of the world’s cocoa beans are produced, diminished rainfall and
extreme heat could hinder the development of the April 2013 to September 2014 mid-crop. Even
under normal weather circumstances, only a small proportion of a cocoa tree’s flowers develop
into fruit over a period of about five months. And it takes a whole year’s crop from one tree to
make 450 grams of chocolate, which is approximately 90 Hershey’s Kisses chocolate. Every day,
70 million Hershey’s Kisses are produced.
The supply shortfall is emerging just as Americans and Europeans are buying more chocolate,
particularly the darker varieties, for health reasons. Dark chocolate often requires more cocoa
beans per ounce than milk chocolate.
As the world price of cocoa bean remains among the highest in years, companies like Mars and
Hershey have not only raised their chocolate prices to cover increasing costs, but also turned to a
cheaper cocoa variety developed in Ecuador. “A price increase was necessary to protect our
margins,” said Hershey's Chief Executive John P. Bilbrey. In fact, despite rising costs, Hershey’s
quarterly profits rose 5.4% in July 2014.
But chocolate lovers will not let higher chocolate prices keep them from their craving, said Bilbrey.
Craving for chocolate can be attributed to the release of a chemical called anandamide, which
induces a relaxing feeling and improves one’s mood. Moreover, unlike other foods like cheese and
brewed coffee, the aroma and taste match up with the pleasure of anticipation and reward in
eating, thus making eating chocolate a highly pleasurable experience.
Source: Various, Mar 2013 – May 2015
Figure 1: Market share (in percentage) of the leading chocolate companies in the
United States in 2014
Hershey
44.2
Mars
29.5
Nestlé
5.8
Lindt/Ghirardelli
4.8
Russell Stover
4.4
Others
11.3
0
10
20
30
40
50
Source: Statista 2015
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Extract 2: Why so little chocolate variety?
The 1960s’ diverse chocolate market did not last, as the bigger players began eating up their
smaller rivals. This has helped thin the market down to around 150 chocolate producers in the US
today. Chocolate is a US$16 billion industry in the US, but the bulk of the profits end up with the
bigger players.
Size tilts the playing field, enabling bigger players to dish out huge sums in “slotting fees” for shelf
space, ensuring that you will see the same pattern of brands prominently displayed in any WalMart, Giant or 7-11 store. The barriers to entry today are formidable, Steve Almond, author of
CandyFreak, learned. “Most of the equipment intended for chocolate making is for larger-scale
production, and the equipment designated for smaller batches is extremely expensive. I’d have to
have billions of dollars just to be able to scale up production enough to make a decent quality bar
at a competitive price,” he said. “And if it posed any threat to the big players, they would do what
giant chocolate companies do: introduce a similar chocolate bar.”
Lamenting the disappearance of a diverse chocolate market is not just nostalgia. Fewer
companies concocting means dominant players have fewer reasons to innovate. Earlier this
month, the industry buzzed over the major news of the season: Hershey’s first new and original
product in 30 years – Lancaster, which is not acquired and not spun-off an existing brand.
Source: Time, 1 November 2013
Extract 3: US chocolate price fixing suit against Hershey, Mars and Nestlé melts
A US$727 million chocolate price-fixing lawsuit against Hershey, Mars and Nestlé has been thrown
out by the US Middle District Court of Pennsylvania as Chief Judge Conner ruled that the firms’
actions could not be proven to be the result of concerted and collusive action. The firms were
alleged to be spurred by the success of a price-fixing conspiracy in Canada and to have agreed to
collude to raise prices in tandem in the US.
However, the firms contended that the price increases, which were between 2-4 cents for singles
and king-size chocolate bars, were driven by rising ingredient, manufacturing and distribution
costs.
Source: Confectionary News, 27 February 2014
Extract 4: The next big thing in chocolate
Consumer demand for healthier and more natural ingredients is prompting a growing number of
corporate giants, including Hershey and Nestlé USA, to overhaul iconic products that they sell.
Paul Bakus, head of corporate affairs, said that some of the new ingredients will be more
expensive for Nestlé. "The consumer is pretty much in the driver's seat," said Sophie Terrisse,
chief executive of a brand-management firm. "A consumer can make or break a brand with a post,
with a review, with a comment and an idea. Any brand has to listen today harder than they've ever
listened."
Despite dominance in the US chocolate market by a handful of multinational giants, a trend in
favour of bean-to-bar chocolate is growing. Bean-to-bar chocolate, which can cost two to three
times as much as a regular chocolate bar, is made from scratch by small-scale chocolate makers
who buy cocoa beans direct from the farmers who grew them. Though bean-to-bar was a tiny part
of the US$17.7 billion in chocolate sales in 2014, there are at least 75 established bean-to-bar
chocolate makers in the US in 2015. This micro-produced chocolate is more interesting and
diverse, with individual chocolate makers allowing the flavours of very small batches of cocoa
beans from individual areas to emerge.
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In view of changing consumer demand, both Mars and Hershey have delved into the premium
chocolate (typically characterised by an emphasis on the pursuit of quality) realm previously
occupied primarily by smaller-scale specialty manufacturers, including bean-to-bar chocolate
makers. Consumer familiarity gives these brands an advantage over others. In addition, most
average consumers are unaware of the difference between smaller specialty and larger premium
chocolate manufacturers, said Judy Ganes-Chase, president of J Ganes Consulting. She added
that the shine of chocolate health claims will soon fade as consumers become desensitised to the
fad of value-added superfoods, especially if economic uncertainty were to arise.
Source: Various, Jan 2009 – Apr 2015
Questions
(a)
(b)
Explain either one demand or one supply factor that has led to a rise in the world price
of cocoa bean.
[2]
What can you conclude from evidence in Extract 1 about the value of the price elasticity
of supply of cocoa beans in Ivory Coast?
[2]
(c)
Using a relevant elasticity concept, explain the statement in Extract 1, “But chocolate
lovers will not let higher chocolate prices keep them from their craving.”
(d)
Substantial internal economies of scale is a form of barriers to entry. Using information
from Extract 2:
[2]
(i)
Explain the type of internal economies of scale that can be reaped by firms in the
US chocolate market.
[2]
Explain one other form of barriers to entry facing potential entrants into the US
chocolate market.
[2]
Identify the type of market structure that exists in the US chocolate market and explain
the reason for your choice.
[2]
Discuss whether monopoly power in the US chocolate market is beneficial to
consumers.
[8]
To what extent are cocoa bean shortage and changing consumer tastes likely to
threaten the existing large profits of the big chocolate firms?
[10]
(ii)
(e)
(f)
(g)
[Total: 30]
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Question 2
Economic recovery and free trade in a globalised world
Extract 5: The "three arrows" of Abenomics
Deflation, a sustained fall in the general price level, poses clear risks to the economy. One familiar
danger is that consumers will put off buying in the hope that things will get cheaper later on, muting
demand. On the other hand, when prices fall across an economy but wages do not, it hurts
producers who would hold back their expansion and hiring plans causing employment to stagnate
or even decline. Thus, deflation can be bad for jobs and growth.
To help Japan escape from deflation and spur recovery, the “three arrows” of Prime Minister Abe’s
economic program, commonly known as "Abenomics" were formulated. Generally, Abenomics
consists of: (i) monetary easing, (ii) fiscal stimulus and (iii) structural reforms.
First Arrow - Quantitative Easing: The first of the three arrows entails aggressive quantitative
easing (QE). It involves substantial open market operations to boost liquidity in the financial
system in order to stimulate the weak economy. However, some analysts opined that the most
significant effect of Japan's quantitative easing is on its currency and not on the wider economy
due to sluggish domestic loan demand. The yen has depreciated over 45 percent against the US
dollar in nominal terms since 2012, which is largely attributed to the first round of QE. In addition,
the Bank of Japan put further depreciation pressure on the yen after announcing at the end of
October 2014 that it would conduct more QE.
Second Arrow - Fiscal Stimulus: In Oct 2012, Japan's cabinet approved a 422.6 billion yen
(US$5.3 billion) economic stimulus package of subsidies and tax grants. However, large public
debt makes it difficult for Japan to use fiscal policy to pump-prime the economy. Japan has a
staggering public debt of 160 percent of GDP. As a result, fiscal consolidation, a policy aimed at
reducing government deficits and debt accumulation is on the cards as Japanese authorities seek
to put their public finances on a more sustainable footing. As part of fiscal consolidation, the
consumption tax was hiked in April 2014 from 5 to 8 percent, and a planned second-stage increase
to 10 percent at the end of 2015 was announced.
Third Arrow – Structural Reform: Over the medium and long term, the Japanese government will
take ambitious structural reforms to permanently increase domestic demand. This would include
measures to raise household income through greater labour force participation and higher
earnings. In addition, the third arrow would also include measures to facilitate new domestic
opportunities for investment, by opening up domestic sectors, particularly services, to new
products and new competition through deregulation. The measure of the third arrow will be its
success in raising Japan’s potential growth rate.
The first two arrows were actively employed at the launch of Abenomics in 2012. Aggressive
monetary policy and initial expansionary fiscal policy contributed to a recovery from the late-2012
slump and real GDP grew by 1.6 percent in 2013. However, in the second quarter of 2014, after
the introduction of a 3 percentage point increase in the consumption tax, economic growth fell
sharply. As a result, attention has now turned to the sustainability of the recovery as nominal wage
growth has failed to offset the impact of the consumption tax hike. In early 2014, prices have fallen
on the back of plunging global oil prices, and the country may again face deflation in the coming
year. Going forward, more progress on the third arrow of structural reform may be required to
raise long-term growth prospects in Japan.
Source: Various, dated Oct-Dec 2014
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Extract 6: Durable economic recovery in Japan
As Japan adopts Abenomics to bring about a durable recovery, it is vital for the global and
Japanese economies that its economic policies work primarily through an increase in domestic
demand. Sustaining domestic demand growth will depend on sustained rise in business
investment and household consumption that need to be supported by nominal wage increases that
exceed inflation. In this respect, it is important that Japan carefully calibrate the pace of overall
fiscal consolidation. This is because expansionary monetary policy cannot offset the effects of
excessive fiscal consolidation. Above all, boosting the waning consumer confidence remains a key
challenge in the prevailing deflationary climate.
Source: Report to US Congress on International Economic
and Exchange Rate Policies, 15 Oct 2014
Extract 7: Globalisation poses challenges to free trade
According to David Ricardo, the gains from trade come from our differences, not our similarities;
and the greater the differences, the larger the potential gains. When a trading country is no longer
constrained to making products and services to only match domestic demand, both consumers
and producers win.
However, the complexity of today’s interconnected global markets sometimes creates challenges
for supporters of this approach towards international trade. One prime challenge is the conduct of
rampant unfair trade practices, key being currency manipulation, which has vexed the United
States for many years. In essence, currency manipulation allows governments of foreign countries
to suppress the value of their currencies to lower the prices of their exports and increase the prices
of their imports. As most of the intervention takes place in US dollars, the dollar has been pushed
to overvalued levels compared to her trading partners, such as Japan. Recent remarks from
Japanese Prime Minister Shinzo Abe underscore Japan’s dependence on a weak yen as an
export-driven growth policy, “No matter how much sweat they put in, no matter how good their
ideas, businesses couldn’t compete due to the strong yen, and many jobs were lost.”
As a result of currency manipulation, the US current account deficit has averaged $200 billion to
$500 billion per year higher and it was estimated that “the United States has lost 1 million to 5
million jobs due to currency manipulation.” Several other countries, including the weak euro area
economies, emerging-market countries such as Brazil and India, and many small and poor
countries, have also suffered the ill effects of currency manipulation, such as increased
unemployment.
In light of large and widespread trade effects due to currency manipulation, the US has called for
free trade agreements to address these issues and help ensure that participating countries benefit
from the gains from trade. One such agreement is the Trans Pacific Partnership (TPP), a
preferential free trade agreement currently being negotiated by countries such as Japan, Malaysia,
Mexico, New Zealand, Singapore, Vietnam and the United States. Bridging both sides of the
Pacific, the TPP will bring together one third of world trade. It is recommended that adding a
"currency chapter" in the TPP, including clear obligations to avoid currency manipulation in the
TPP and sanctions against violators could help to deter future currency manipulation.
Source: Various Sources dated Oct 2014 - Jan 2015
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Table 1: Japan - Selective Economic Indicators 2011 – 2014
Annual percentage change
Real GDP
Composition of
GDP:
Private
Consumption
Public
Consumption
Gross
fixed
capital
formation
Exports (goods
and services)
Imports (goods
and services)
% GDP
(in 2013)
100
2011
2012
2013
2014
(forecasted)
0.4
-0.5
1.8
1.6
61.1
0.3
2.3
2.1
-1.0
20.6
1.2
1.7
1.9
0.3
21.7
1.4
3.4
3.2
2.9
16.2
-0.4
-0.2
1.5
7.8
19.0
5.9
5.3
3.1
6.5
Other Macroeconomic Indicators:
Inflation Rate (%)
-0.3
0.0
0.4
-
Unemployment Rate (%)
4.6
4.3
4.0
3.7
Interest rate (%)
0.10
0.10
0.10
0.10
Exchange rate (Yen per USD)
76.96
86.75
105.3
-
Population (million)
128.0
127.9
127.6
-
Source: http://www.focus-economics.com/countries/japan
Figure 2: Japan Balance of Trade (JPY Billion)
Jul 2012
Jan 2013
Jul 2013
Jan 2014
Source: tradingeconomics.com
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Questions
(a) (i)
(ii)
(b) (i)
(ii)
(c) (i)
(ii)
(d)
(e)
Using Table 1, what evidence is contained in the data to suggest that Japan
experienced a deflation?
[1]
Using AD-AS analysis, explain how deflation can be "bad for jobs". (Extract 5)
[2]
Explain how a fall in a country's interest rate might affect its exchange rate.
[2]
Explain why "expansionary monetary policy cannot offset the effects of excessive fiscal
consolidation." (Extract 6)
[3]
Using Figure 2, describe what happened to Japan's balance of trade over the period Jul
2012 to Jan 2014.
[2]
Explain one factor that limits the extent to which "currency manipulation" by Japan can
benefit its balance of trade.
[2]
Discuss whether Japan should let its economic policies work primarily through an
increase in domestic demand or external demand to achieve economic recovery.
[8]
The complexity of today’s interconnected global markets sometimes creates challenges
for supporters of free trade. (Extract 7)
In the light of the data provided, discuss the extent to which free trade is beneficial in a
globalised world.
[10]
[Total: 30]
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Blank Page
Copyright acknowledgements:
Question 1 Extract 1:
@ Global Cocoa Prices Could More than Double by 2020 if Output Lags – Petra; Reuters; 26 Mar 2013;
http://www.reuters.com/article/2013/03/26/indonesia-cocoa-deficit-idUSL3N0CI13Q20130326
@ Chocolate Craving Comes from Total Sensory Pleasure; BBC News; 27 July 2013; http://www.bbc.com/news/health-23449795
@ Chocolate Prices Soar in Dark Turn: Consumer Shift to Dark Chocolate Further Squeezing Cocoa Supplies; The Wall Street Journal; 22
September 2013; http://www.wsj.com/articles/SB10001424052702303983904579091120112729130
@ Hershey Profit Up 5.4% Despite Rising Costs; The Wall Street Journal; 24 July 2014; http://www.wsj.com/articles/hershey-posts-profitincrease-despite-rising-costs-1406201376
@ Artisanal, Hand-Crafted Chocolate is a Growing Niche; Los Angeles Times; 28 February 2015; http://www.latimes.com/business/la-fiartisan-chocolate-20150228-story.html#page=1
@ Harvesting and Processing Cocoa Beans: ‘Theobroma Cacao’ – The Cocoa Tree; Mondelez Australia Pty Ltd and Mondelez Austrialia
(Foods) Ltd.; accessed 6 May 2015 https://www.cadbury.com.au/about-chocolate/harvesting-and-processing-cocoa-beans.aspx
Question 1 Figure 1: Statista, 2015
Question 1 Extract 2: Why so little chocolate variety?, Time, 1 November 2013
Question 1 Extract 3: US chocolate price fixing suit against Herseys, Mars, Nestle melts, Confectionary News, 27 Feb 2014
Question 1 Extract 4:
@ Premium Chocolate Holds Steady in Tough Economy;
The Wall Street Journal; 7 January 2009;
http://www.wsj.com/articles/SB123129657237259887
@ Why Doesn’t Britain Make Its Own Chocolate from Scratch?; The Telegraph; 14 October 2013;
http://www.telegraph.co.uk/foodanddrink/10370161/Why-doesnt-Britain-make-its-own-chocolate-from-scratch.html?mobile=basic
@ The Revival of Bean-to-Bar Chocolate-Makers; On the Cocoa Trail; 22 November 2013; http://onthecocoatrail.com/2013/11/22/1741/
@ African cocoa traders want bigger slice of the profits; BBC News; 13 June 2014; http://www.bbc.com/news/business-27831038
@ I Should Cocoa: Why We’re All Going Made for Bean-to-Bar Chocolate; The Telegraph; 3 January 2015;
http://www.telegraph.co.uk/foodanddrink/11319304/I-should-cocoa-why-were-all-going-mad-for-bean-to-bar-chocolate.html
@ Artisanal, Hand-Crafted Chocolate is a Growing Niche; Los Angeles Times; 28 February 2015; http://www.latimes.com/business/la-fiartisan-chocolate-20150228-story.html#page=1
@ Going All Natural: Major Food Companies Taking Out Artificial Ingredients; www.guampdn.com; 9 April 2015;
http://www.guampdn.com/article/20150409/LIFESTYLE/304090014/Going-all-natural-Major-food-companies-taking-out-artificialingredients
Question 2 Extract 5:
@ Report to Congress on International Economic and Exchange Rate Policies, 15 October 2014
@ Currency Manipulation and its Distortion of Free Trade, 1 December 2014
Question 2 Extract 6: Report to Congress on International Economic and Exchange Rate Policies, 15 October 2014
Question 2 Extract 7:
@ Report to Congress on International Economic and Exchange Rate Policies, 15 October 2014
@ Currency Manipulation and its Distortion of Free Trade, 1 December 2014
@ Currency Manipulation And Its Impact On Free Trade, Forbes / Opinion, dated 21 January 2015
Question 2 Table 1: http://www.focus-economics.com/countries/japan
Question 2 Figure 2: Tradingeconomics.com
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©HCI C2 BT2 2015
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